Economy Falls Short of Hype

Real GDP grew at a 4.1% pace in the second quarter following slight upward revisions to the first quarter and 2017. Gains were driven by a rebound in consumer spending, a sharp narrowing of the trade deficit, solid if not spectacular gains in business investment and a pickup in federal spending tied to increases in the fiscal year 2018 budget. Housing and the amount of inventories held by businesses disappointed.

The housing market is showing signs of cooling despite new household formation and pent-up demand among entry-level buyers. The sticking point had been supply constraints for existing and new homes on the market. Escalating prices and rising mortgage rates are eroding affordability. The silver lining may be a sharp drop in foreign investment in some of the strongest housing markets; overseas buyers had pushed prices even further out of reach for first-time buyers. The housing market is unique in that it is among the most sensitive to interest rate shifts, even small ones, and tends to peak well ahead of other sectors in the economy.

The improvement in trade, which accounted for more than one percent of the 4.1% growth in the second quarter, was critical. Much of the surge in exports may be attributed to a one-time jump in soybean exports; U.S. trading partners snapped up supplies before tariffs went into effect in June. A jump in auto imports wasn’t enough to offset that surge in soybean exports but vehicle manufacturers are hedging; that showed up in a jump in imports from countries that could face new tariffs. Look for trade to be a drag on growth during the remainder of the year.

Finally, inventories came in much weaker than expected but rebuilding in the second half could provide a tailwind for growth. The question is, how much are firms willing to stock up with the threat of a trade war?

Bottom Line

Growth has picked up and remains on solid footing even if the pace of growth during the second quarter is not sustainable. The best way to look at quarterly growth figures is as a moving average. GDP came in slightly above 3% in the first half of the year. We are looking for a bit less than that in the second half, which should deliver nearly 3% growth for the year.